National Retail Sales Tax: Who would bear the burden?

Under a national retail sales tax, the wealthiest households in the country would receive stunningly large tax cuts. Households in the top 1 percent of the income distribution have an average income of about $475,000. Their average tax cut would be $79,000, or more than the incomes of all but about 8 percent of households. Put another way, the roughly 1.1 million taxpayers in this top 1 percent would save a total of $87 billion on their taxes each year. This cut would be financed by tax increases on the bottom 92 percent of households. Households with income between $5,000 and $50,000 would face an average tax increase of over $1,000.

The existing tax system, which includes income, corporate, estate, and payroll taxes, is generally progressive. Households with incomes between $5,000 and $10,000 pay an average effective tax rate-defined as taxes actually paid divided by income-of under 9 percent. The average effective tax rate rises with income to about 25 percent for households with incomes between $100,000 and $200,000, and then to about 32 percent for the fewer than 1 percent of households with incomes above $200,000. The current system is not completely progressive, however. Households in the lowest income group, those with incomes less than $5,000, pay an average effective rate of almost 12 percent, which is higher than households in the next group.

The proposed national retail sales tax has been shown to be a relatively proportional tax for much of the population; that is, effective rates would vary little with income. Average effective tax rates would at first rise modestly as incomes rise, from about 20 percent for households with incomes between $5,000 and $10,000 to 23 percent for households in the $20,000 to $40,000 range, and would then fall back to 20 percent as income rises to $100,000 to $200,000. At the extremes, however, the national retail sales tax would be quite regressive. The average rate for the lowest income group would exceed 33 percent, while the average for the top group would fall to less than 16 percent. These results suggest that converting to a national retail sales tax would be a highly regressive shift when measured against annual income.

A common claim is that a reform that includes a national retail sales tax would be "pro-family." Advocates usually point to the proposed demogrant as proof of this assertion. However, the demogrant is only one policy that affects children and families with children. Families with children would likely be hurt both by the elimination of current deductions for health insurance, mortgage interest, and state and local income and property taxes (which finance schools and other government services) and by the elimination of various tax credits (the earned income credit, child care credits, education credits, and child credits). Moreover, at any given income level, families with children have higher consumption requirements than couples without children, so that switching to a consumption tax would present an inherent disadvantage for families with kids.